T. Clarke (LON:CTO) is a building services group that has the look of a good discount in it. Unlike Gleeson (LON:GLE), Clarke does not build houses or acquire strategic land. The current share price of 93p (as at 1 February 2011) gives the company a market value of £38m. Based upon the 2009 basic EPS of 10p, this represents a PER of 9x. The Company is listed on the Main Market.
In the past five years, the shares have hit a high of 265p (May 2006) and a low of 91p (Jan 2011). A peak-to-trough fall of 65%.
I do not own any shares in CTO at the time of writing.
The Company can trace its roots back to 1889 and listed on the LSE in 1946.
The Company acts as main contractor,subcontractor or specialist contractor on a variety of building projects in a wide range of industry sectors, including retail, education and commercial. For example, the Company acted as Principal Contractor on the new Westfield Shopping Centre.
The Company is made up of 13 group companies, trading from 14 locations and has over 1,300 employees.
In the Annual Report, the Company provides an analysis of key KPIs (eg turnover per employee) compared to selected (their selection!) competitors and comes out quite favourably, which is positive. However, the Company's average operating margin over a 10 year period is about 5% (my calculation) which is probably there or abouts in the construction industry, but shows that there is not much fat to cut away when times get tough.
The strategic focus of the Company appears to be: concentrating on particular sectors, tight cost control, harmonising the 'T Clarke' brand and strategic acquisitions as they arise (eg acquisition of D&S in March 2010 for £12m and DG Robson in August 2010 for £6m).
Risks & Challenges
The following analysis is based on the 12 months to December 2009 (FY09) unless otherwise stated
1 - Assets - the NAV at Dec 09 was £25m compared to a market cap of £38m, meaning that the market value is trading at a 50% premium to net assets. Worse still, is that £12m of net asset value is attributed to goodwill (the premium arising on acquisitions). Also, when you dig a little deeper, you come across a pension scheme deficit (£6m - an increase of £4m in the year) and £11m of 'Construction contracts' which is their estimate of the value of the work that they have provided on live contracts at the balance sheet date. Inherent within this is a fundamental level of certainty as outlined in Note 1 (p67) due to the "difficulty of forecasting the final costs to be incurred on the contract". No surprises really, but it is easy to look over. For all this, I don't like the flavour of the balance sheet. Fail
2 - Market Value - a market cap of £38m is below the floor of £50m. The purpose of the floor is to try and screen out tiddlers, but I'll use my discretion and let CTO through as it normally trades above a £50m market value. Rules are there to be broken occasionally.Pass(ish)
3 - Cash Flow - (a) net current assets of £12m is positive and (b) operating cash of £1.3mafter working capital movements and interest (NB this is a huge fall from the £29m in FY08). Out of this, we need to provide for capex (£0.2m), tax (£2m - FY09 P&L) and dividends (£5.2m). Something has to give in 2010/11, and it does (see Update below). The cash flows are lumpy and swing a lot from year to year, which is probably a reflection of the contractual nature of the business. Fail
4 - Debt - there was net cash of £23m as at Dec 09, however acquisitions have been made since the year-end and therefore, I am going to use the £7m net cash as at June 10 for EV purposes. Based on a market cap of £38m and net cash of £7m, the EV is £31m. EBITDA for FY09 was c£8m (adjusting discontinued items), which implies an EV/EBITDA ratio of 3.9 times, which is reasonable. Pass
5 - PER - the 2009 EPS was 10p, implying a PER of 9.3x based on the current price. Based on 10 year average EPS of 14p, the PER falls to 6.6x. Pass
6 - Yield - the 2009 DPS was 13p, representing a yield of 14%. The average dividend over the last 10 years is 10p, equating to a yield of 10.7%. This level of dividend screams "unsustainable" to me.
There was a deficit in earnings cover (0.75 times covered) in 2009 (EPS of 10p v DPS of 13p), but the directors decided to hold the dividend at the 2008 level. Over the long-term a 10 year average DPS of 10p has been covered 1.4 times by 10 year average EPS (14p). Whilst the cover is not quite as high as I would like, it suggests that a high dividend is an important consideration for the directors, which is positive even if the current level is unsustainable. Pass
7 - ROE - the 2009 ROE was 13% and the average annual 10 year ROE is 30.3% (source: Sharelockholmes). This seems high, but is probably explained by relatively high levels of dividends, which keeps the denominator low. Pass
8 - Directors - As at March 10, the directors' interest amounted to 80,000 shares in total, which is trifling. Whilst overall remuneration appears to be reasonable for a company of this size, and the bonus element is linked to generating certain levels of Profit Before Tax (minimum threshold of £7.5m), I am concerned that directors have not put enough of their money where their mouth is by buying "cheap" shares. The new FD acquired a whopping 2,000 shares in December (why bother at this level?). Fail
9/10 - Buy or Bye? Based upon a 10 year average of EPS of 14p and a 10 year average PER of 11.8x, we arrive at a 'long-term fair price' of 165p. The current price of 93p therefore represents a 44% discount to this long-term price. Buy
On the face of it, the interim results released in August 2010 were reasonably positive. The dividend level was held "reflecting the board's confidence in the underlying strength of the business" despite noises about a tough trading environment
A trading update was provided on 14 January 2011, which made reference to the tough trading conditions and margins being under "extreme pressure", resulting in the likely outcome for FY10 to be below current market expectations and for FY11 to be even worse. Although the Company had £7m of cash at Dec 2010, it is the Board's intention to reduce to the final dividend to that of its interim dividend [making 8.5p for the year] and to re-base the dividend thereafter (no details on how). The order book amounted to £190m at Dec 2010. All in all...ouch.
The 2010 results are scheduled to be announced on 18 March.
It's easy to see why the Company is relatively unloved when you throw in the global economy, severe margin pressure and the recent negative case studies of ROK and Connaught. It's not all doom and gloom though as the Company has a good order book (which should turn into £7-10 of operating profit in due course) and cash on the balance sheet, but the immediate future is going to be tough.
Whilst the Company passes more Rules than it fails, what troubles me most is the flavour of the balance sheet and the nature of the business model to give me sufficient confidence of future profitability and when and how it turns to cash. I am unable to get comfortable on hitting my target 15% IRR despite the long-term ROE being good (is this just a function of the 'good' years?). I can't see any moat or margin of safety to give me reassurance.
For these reasons, and although I think T Clarke is a good company with lots of heritage, I am going to pass on the opportunity to invest. Given that my concerns apply to the sector as a whole, I am going to avoid looking at opportunities in the construction and house-building sectors in the future, even despite the large perceived discounts.
IMPORTANT - this blog acts as a commentary for my own analysis of publicly available information on companies that interest me. It does not constitute any recommendation to buy or sell any shares or investments that I may or may not hold. If you want professional advice, go to a broker (who has the necessary authorisation and professional indemnity insurance!)